Good time to invest in small- and mid-caps

That's a good strategy if you have an investment horizon of 5 years; if not, it's better to stay away

Between February 13 and now, the BSE exchange’s Sensitive Index or Sensex has gained a little over 18 per cent and the National Stock Exchange’s 50-stock Nifty index about 18.5 per cent. The high-beta segment has risen more — the BSE mid-cap index has gained close to 21 per cent and the small cap index 23.5 per cent. Anticipating an economic revival with the new government, fund houses look to tap on to the run-up in equities with numerous new fund offers (NFOs). They are especially betting on small businesses. Termed emerging business funds, it is felt these are better placed to take advantage of a resurgent economy. L&T Mutual Fund and Birla SunLife Asset Management Company brought out emerging business NFOs, which closed last week. These funds are closed-ended. Many others like SBI MF, Kotak MF, Mirae Asset MF and Canara Robeco MF also invest in this theme.

Explains Renu Pothen, research head at iFAST Financial India, “Emerging business theme-based funds basically invest into mid and small-cap stocks, which normally have the potential to grow faster than large-cap stocks on account of their strong competitive advantage over peers; they also have strong management teams. These stocks will also be trading below their fair value, which means it is only a matter of time before they unlock their values.”

“While these businesses have huge potential to grow, investors need to catch them at the right time, not easy for the majority of  retail investors,” says Vidya Bala of FundIndia.com.

Therefore, investors who can tolerate huge bouts of volatility in the short term and have a high risk–high return profile should invest in this theme. Once invested, he/she must commit to stay invested for at least five years. Hence, people with an investment horizon below five years should strictly avoid the theme, says Achin Goel, head, wealth management and financial planning, at Bonanza Portfolio. At the same time, in the long term, these stocks are expected to grow much more than blue-chip ones. So, a time horizon of five to seven years might help portfolios grow manifold, provided the fundamentals and general economic situation remain favourable. “We have been positive on the mid-cap and small-cap segment for a long time. In the beginning of 2011, we had advised investors to take an exposure in mid-cap funds, as the mid-cap index was trading at a discount to its all-time high. We continue to maintain this stand, as the mid-cap index is trading at a discount to its peak and as there are a number of value stocks in this space,” says Pothen.  With an investment horizon of more than five years, even Goel feels the theme looks promising.

Inexpereinced investors should stay away from this category, says Bala. They should stick to the good old equity diversified funds that also invest in small businesses, though in a small proportion. Savvy investors could take up to 10 per cent exposure in these funds.

Pothen warns that mid and small cap funds will underperform when the macro-economic fundamentals are not in a great shape, as a result of which markets are going through a bearish phase. However, as the markets recover on the back of improving fundamentals, these funds will see a strong momentum. These funds would be investing in segments of markets that do not rule high liquidity on the bourses.